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A

PROJECT REPORT

ON

THE STUDY

OF

FOREX MARKET AND RISK MANAGEMENT

(SUBMITTED IN PARTIAL FULFILLMENT FOR THE AWARD OF

MASTERS DEGREE IN BUSINESS ADMINISTRATION)

UNDER THE GUIDENCE OF: SUBMITTED BY:

MS. PUJA MANN SHIKHA SRIDHARH.O.D., M.B.A. Dept., MBA/04/54M. SANDEEP JAG!AN!e"t#e, M.B.A Dept. $004%$00&

N.C.COLLEGE OF ENGINEERING, ISRANA

(KURUKSHETRA UNIERSITY, KURUKSHETRA)

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ACKNOWLEDGEMENT

Every person who touches heights, reaches that level with the grand support,blessings of his /her loved ones, guides, teachers, elders.He cant deny the fact that

they are the people behind his success. I am very thankful to the people who provided

me their help and support.

I owe my special thanks to M!. PUJA MANNH!", #$% "epartment& for

her grand support, guidance, and for being a helping hand in every possible

way in this pro'ect.

I am very thankful to M". SANDEEP JAGLAN (ecturer, #$%

"epartment& for devoting his precious time and for leaving no stone unturned

for the completion of this pro'ect.

I would also like to e)tend my thanks to my supporting faculty of

N.C.C.E., ISRANA, KURUKSHETRA UNIERSITY.

THANK YOU ALL#

*

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EXECUTIE SUMMARY

+he pro'ect undertaken is based on the study of foreign e)change market and risk

management in general as well as in the fore) market.

FOREIGN EXCHANGE MARKET$ oreign e)change market is a market where

foreign currencies are bought - sold.

oreign e)change market is a system facilitating mechanism through which one

countrys currency can be e)changed for the currencies of another country.

+he purpose of foreign e)change market is to permit transfers of purchasing power

denominated in one currency to another i.e. to trade one currency for another.

+he pro'ect covers various trading areas of fore) market such as, spot market, forwardmarket, derivatives, currency futures, currency swaps etc. It helps in understanding

various trend patterns and trend lines. hat considerations are kept in mind while trading

in fore) market and why one should enter such market is studied under this pro'ect.

%nother part of this pro'ect covers isk #anagement in general as well as in fore)

market. R%!& M''*+* is the process of measuring, or assessing risk and then

developing strategiesto manage the risk. In general, the strategies employed include

transferring the risk to another party, avoiding the risk, reducing the negative effect of the

risk, and accepting some or all of the conse0uences of a particular risk.

% person has to face risk whether hes in business or is entering the fore) market.o, he

uses various strategies and methods to overcome that risk.

+he data used in this pro'ect has been collected from websites based on related topics and

various books of fore) market and risk management. +he information displayed may be

limited,as each and every aspect related with the pro'ect that is provided by the avilablesources might not be complete in all respects.

2

http://en.wikipedia.org/wiki/Measurementhttp://en.wikipedia.org/wiki/Risk_assessmenthttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Strategyhttp://en.wikipedia.org/wiki/Measurementhttp://en.wikipedia.org/wiki/Risk_assessmenthttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Strategy

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OBJECTIES OF THE STUDY

+o study ore) market - isk management in general as well as in fore)market.

+o have a knowledge of different types of fore) markets and various

0uotations in ore) markets.

+o study risk in the ore) market as well as volatility in ore) market.

+o have a knowledge of how people trade in fore) market.

+o study the factors that force different types of people in different markets.

+o study various strategies of risk management.

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HISTORY

B"%*- %!/"0 /- F/"*1 "'2%

Initially, the value of goods was e)pressed in terms of other goods, i.e. an economy based

on barter between individual market participants. +he obvious limitations of such a

system encouraged establishing more generally accepted means of e)change at a fairly

early stage in history, to set a common benchmark of value. In different economies,

everything from teeth to feathers to pretty stones has served this purpose, but soon

metals, in particular gold and silver, established themselves as an accepted means of

payment as well as a reliable storage of value.

!riginally, coins were simply minted from the preferred metal, but in stable political

regimes the introduction of a paper form of governmental I!4s gained acceptance during

the #iddle %ges. uch I!4s, often introduced more successfully through force than

persuasion were the basis of modern currencies.

$efore the irst orld ar, most central banks supported their currencies with

convertibility to gold. %lthough paper money could always be e)changed for gold, in

reality this did not occur often, fostering the sometimes disastrous notion that there was

not necessarily a need for full cover in the central reserves of the government.

%t times, the ballooning supply of paper money without gold cover led to devastating

inflation and resulting political instability. +o protect local national interests, foreign

e)change controls were increasingly introduced to prevent market forces from punishing

monetary irresponsibility.

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In the latter stages of the econd orld ar, the $retton oods agreement was reached

on the initiative of the 4% in 6uly 1733. +he $retton oods 8onference re'ected 6ohn

#aynard 9eynes suggestion for a new world reserve currency in favour of a system built

on the 4 dollar. !ther international institutions such as the I#, the orld $ank and

:%++ were created in the same period as the emerging victors of * searched for a

way to avoid the destabilising monetary crises which led to the war. +he $retton oods

agreement resulted in a system of fi)ed e)change rates that partly reinstated the gold

standard, fi)ing the 4 dollar at 4"25/o; and fi)ing the other main currencies to the

dollar < and was intended to be permanent.

+he $retton oods system came under increasing pressure as national economies moved

in different directions during the si)ties. % number of realignments kept the system alivefor a long time, but eventually $retton oods collapsed in the early seventies following

president =i)on>s suspension of the gold convertibility in %ugust 17?1. +he dollar was no

longer suitable as the sole international currency at a time when it was under severe

pressure from increasing 4 budget and trade deficits.

+he following decades have seen foreign e)change trading develop into the largest global

market by far. estrictions on capital flows have been removed in most countries, leaving

the market forces free to ad'ust foreign e)change rates according to their perceived

values.

$ut the idea of fi)ed e)change rates has by no means died. +he EE8 introduced a new

system of fi)ed e)change rates in 17?7, the European #onetary ystem. +his attempt to

fi) e)change rates met with near e)tinction in 177*

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+his pro'ect is fairly advanced now and the final structure and fi)ed levels were decided

in #ay 177B. %fter this a dangerous three

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INTRODUCTION TO TRADING FOREX

F/"*% E13'*

+his short introduction e)plains the basics of trading ore) online, a brief e)planation of

the markets and the ma'or benefits of trading ore) online. +here are also two scenarios

describing the implications of trading in abear as well asbull market to better ac0uaint

you with some of the risks and opportunities in the largest and most li0uid market in the

world.

OERIEW

oreign e)change , fore) or 'ust ore) are all terms used to describe the trading of the

world>s many currencies. +he fore) market is the largest market in the world, with trades

amounting to more than C1.5 trillion every day. +his is more than one hundred times the

daily trading on the =DE =ew Dork tock E)change& . #ost fore) trading is

speculative , with only a few percent of market activity representing governments> andcompanies> fundamental currency conversion needs.

B

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4nlike trading on the stock market, the fore) market is not carried out by a central

e)change, but on the interbankF market , which is thought of as an !+8 over the

counter & market. +rading takes place directly between the two counterparts necessary to

make a trade, whether over the telephone or on electronic networks all over the world.

+he main centres for trading are ydney, +okyo, (ondon, rankfurt and =ew Dork. +his

worldwide distribution of trading centres means that the fore) market is a *3

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TRADING ON MARGIN

+rading onmargin means that you can buy and sell assets that represent more value than

the capital in your account. ore) trading is usually done with relatively little margin

since currency e)change rate fluctuations tend to be less than one or two percent on any

given day. +o take an e)ample, a margin of *.@ means you can trade up to C5@@,@@@

even though you only have C1@,@@@ in your account. In terms of leverage this

corresponds to 5@J1, because 5@ times C1@,@@@ is C5@@,@@@, or put another way, C1@,@@@

is *.@ of C5@@.@@@. 4sing this much leverage gives you the possibility to make profits

very 0uickly, but there is also a greater risk of incurring large losses and even being

completely wiped out.

+herefore, it is inadvisable to ma)imi;e your leveraging as the risks can be very high.

1@

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RESEARCH METHODOLOGY

+o define the research methodology, one has to go step by step. %ny research

methodology involves following stepsJ

I. G!$(E# E8!:=I+I!=

II. 4KED ! (I+E%+4E

III. HDG!+HEI !#4(%+I!=

IK. EE%8H "EI:=

K. %#G(E "EI:=

KI. "%+% 8!((E8+I!=

KII. %=%(DI %=" I=+EGE+%+I!=.

RESEARCH PROBLEM$ % problem properly defined is half solved.

It is very necessary for any research that research problem should be recogni;ed.

It is critical to any research.

!nce problem is identified, it is to be formulated properly.

Initially the plan is stated in a broad and general way and then it is properly

defined in specific terms.

Groblem formulation means defining a problem precisely.

In this study our research problem isJ +HE +4"D ! !EL #%9E+ %="

I9 #%=%:E#E=+.

LITERATURE SUREY$ +o do any research, we have to review/study previous

literature. or this we studied 6ournals, #aga;ines - $ooks of !EL - I9

#%=%:E#E=+ and also the search engine www.google.com. +o get good results in

any research, it is very essential that this review of literature should be carefully done.+he review of literature survey for this pro'ect includes the followingJ

Elliot ave +his is considered by most e)perienced traders to be the purest

form of technical analysis, since Elliott ave analysis measures investor

psychology. +he ave shows how the psychology of traders, en masse, moves

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from pessimism to optimism on a stock. +his shift occurs in a specific and

measurable. "etecting where a stock is in the pattern can help a trader estimate

the future movements of the market.

K.B. Advisory Ltd. +his program offers you daily technical analysis and trading

recommendations that are based on sophisticated trading strategies developed by

9eith $lack. It boasts a successful three

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participants worldwide, including central banks. It also has an on

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DATA COLLECTION$+he data is of two typesJ GI#%D %=" E8!="D. "ata

are the facts presented to the researcher from the study environment. +he method of data

collection in my study is E8!="D only. $ecause I have collected all the data from

books and from websites.

WHY TRADE FOREX

56 /7" "'2%

!ne of the ma'or advantages of trading fore) is the opportunity to trade *3 hours

a day from unday evening *@J@@ :#+& to riday evening **J@@ :#+&. +his

gives you a uni0ue opportunity to react instantly to breaking news that is affecting

the markets.

S78*"%/" 9%:7%2%0

+he fore) market is so li0uid that there are always buyers and sellers to trade

with. +he li0uidity of this market, especially that of the ma'or currencies, helps

ensure price stability and low spreads . +he li0uidity comes mainly from large and

smaller banks that provide li0uidity to investors, companies, institutions and other

currency market players.

N/ 3/++%!!%/!

+he fact that fore) is often traded without commissions makes it very attractive as

an investment opportunity for investors who want to deal on a fre0uent basis.

+rading the ma'orsF is also cheaper than trading other crossbecause of the high

level of li0uidity. or more information on the trading conditions at a)o $ank,

go to the %ccount ummary on your 8lient tation and open the section entitled

M+rading 8onditionsM found in the top right

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ith a minimum account of 4" 1@,@@@, for e)ample, you can trade up to 4"

5@@,@@@. +he 4" 1@,@@@ is posted on margin as a guarantee for the future

performance of your position

.P"/-% 8/*%'9 % -'99% +'"&*!

ince the market is constantly moving, there are always trading opportunities,

whether a currency is strengthening or weakening in relation to another currency.

hen you trade currencies, they literally work against each other. If the E44"

declines, for e)ample, it is because the 4.. dollar gets stronger against the Euro

and vice versa. o, if you think the E44" will decline that is, that the Euro

will weaken versus the dollar&, you would sell E4 now and then later you buy

Euro back at a lower price and take your profits. +he opposite trading scenario

would occur if the E44" appreciates .

TWO WAYS TO TRADE

+here are two basic approaches to analy;ing currency markets, fundamental analysis and

technical analysis. +he fundamental analyst concentrates on the underlying causes of

price movements, while the technical analyst studies the price movements themselves.

TECHNICAL ANALYSIS

+echnical analysis focuses on the study of price movements. Historical currency data is

used to forecast the direction of future prices. +he premise of technical analysis is that all

current market information is already reflected in the price of that currencyN therefore,

studying price action is all that is re0uired to make informed trading decisions. +he

primary tools of the technical analyst are charts. 8harts are used to identify trends and

patterns in order to find profit opportunities. +he most basic concept of technical analysis

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is that markets have a tendency to trend. $eing able to identify trends in their earliest

stage of development is the key to technical analysis.

FUNDAMENTAL ANALYSIS

undamental analysis focuses on the economic, social and political forces that drive

supply and demand. undamental analysts look at various macroeconomic indicators

such as economic growth rates, interest rates, inflation, and unemployment. However,

there is no single set of beliefs that guide fundamental analysis. +here are several theories

as to how currencies should be valued.

1A

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PSYCHOLOGY OF TRADING

F/7" P"%3%89*! -/" B*3/+% ' B**" T"'2*"

(A). T"'2* ?% ' DISCIPLINED P9'$

+he problem with many traders is that they take shopping more seriously than trading.

+he average shopper would not spend C3@@ without serious research and

e)amination of the product he is about to purchase, yet the average trader would

make a trade that could easily cost him C3@@ based on little more than a feelingF or

hunch.F $e sure that you have a plan in place BEFOREyou start to trade. +he plan

must include stop and limit levels for the trade, as your analysis should encompass

the e)pected downside as well as the e)pected upside.

(B). C7 0/7" 9/!!*! *'"90 '2 L* 0/7" P"/-%! R7$

+his simple concept is one of the most difficult to implement and is the cause of most

traders demise. #ost traders violate their predetermined plan and take their profits before

reaching their profit target because they feel uncomfortable sitting on a profitable

position. +hese same people will easily sit on losing positions, allowing the market to

move against them for hundreds of points in hopes that the market will come back. In

addition, traders who have had their stops hit a few times only to see the market go back

in their favor once they are out, are 0uick to remove stops from their trading on the belief

that this will always be the case. tops are there to be hit, and to stop you from losing

more then a predetermined amountO

+he mistaken belief is that every trade should be profitable. If you can get 2 out of A

trades to be profitable then you are doing well. How then do you make money with only

1?

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half of your trades being winnersP Dou simply allow your profits on the winners to run

and make sure that your losses are minimal.

(C).D/ / +'""0 0/7" "'2*!$

+he reason trading with a plan is the Q1 tip is because most ob'ective analysis is done

before the trade is e)ecuted. !nce a trader is in a position he/she tends to analy;e the

market differently in the hopesF that the market will move in a favorable direction rather

than ob'ectively looking at the changing factors that may have turned against your

original analysis. +his is especially true of losses. +raders with a losing position tend to

marry their position, which causes them to disregard the fact that all signs point towards

continued losses.

D/ / @* * -'"+$

"o not over trade. !ne of the most common mistakes that traders make is leveraging

their account too high by trading much larger si;es than their account should prudently

trade. (everage is a double

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FOREX TRADING EXAMPLES

E1'+89* =

%n investor has a margin deposit with a)o $ank of 4"1@@,@@@.

+he investor e)pects the 4 dollar to rise against the wiss franc and therefore decides to

buy 4"*,@@@,@@@ < his ma)imum possible e)posure.

+he a)o $ank dealer 0uotes him 1.5515s 4" account will show no change. +he 8H account will show a debit of

8H2,1@3,@@@ and a credit of 8H2,137,@@@. "ue to the simplicity of the e)ample and

the short time hori;on of the trade, we have disregarded the interest rate swap that would

marginally alter the profit calculation.

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+his results in a profit of 8H35,@@@ R appro). 4"*B,A@@ R *B.A profit on the deposit

of 4"1@@,@@@.

E1'+89* 5$

+he investor follows the cross rate between the Euro and the 6apanese yen. He believes

that this market is headed for a fall. %s he is less confident of this trade, he does not fully

use the leverage available on his deposit. He chooses to ask the dealer for a 0uote in

E41,@@@,@@@. +his re0uires a margin of E41,@@@,@@@ ) 5 R E45@,@@@ R appro).

4"5*,5@@ E4/4"1.@5&.

+he dealer 0uotes 11*.@5

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F72'+*'9! E>*"0 T"'2*" S/792

K/?

8urrency prices reflect the balance of supply and demand for currencies. +wo primary

factors affecting supply and demand are interest rates and the overall strength of the

economy. Economic indicators such as :"G, foreign investment and the trade balance

reflect the general health of an economy and are therefore responsible for the underlying

shifts in supply and demand for that currency. +here is a tremendous amount of data

released at regular intervals, some of which is more important than others. "ata related to

interest rates and international trade is looked at the closest.

(=).I*"*! R'*!

If the market has uncertainty regarding interest rates, then any bit of news regarding

interest rates can directly affect the currency markets. +raditionally, if a country raises its

interest rates, the currency of that country will strengthen in relation to other countries as

investors shift assets to that country to gain a higher return. Hikes in interest rates,

however, are generally bad news for stock markets. ome investors will transfer money

out of a country>s stock market when interest rates are hiked, causing the country>s

currency to weaken. hich effect dominates can be tricky, but generally there is a

consensus beforehand as to what the interest rate move will do. Indicators that have the

biggest impact on interest rates are GGI, 8GI, and :"G. :enerally the timing of interest

*1

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rate moves are known in advance. +hey take place after regularly scheduled meetings by

the $!E, E", E8$, $!6, and other central banks.

(5).I*"'%/'9 T"'2*

+he trade balance shows the net difference over a period of time between a nations

e)ports and imports. hen a country imports more than it e)ports the trade balance will

show a deficit, which is generally considered unfavorable.

or e)ample, if 4. dollars are sold for other domestic national currencies to pay for

imports&, the flow of dollars outside the country will depreciate the value of the currency.

imilarly if trade figures show an increase in e)ports, dollars will flow into the 4nited

tates and appreciate the value of the currency. rom the standpoint of a national

economy, a deficit in and of itself is not necessarily a bad thing. However, if the deficit is

greater than market e)pectations then it will trigger a negative price movement.

CURRENCY PAIRS

In the ore) market, trading is always in currency pairs, such as E4/4" or 4"/6GD.

F/"*1 S0+@/9 C7""*30 P'%"!T"'2%

T*"+%/9/%*!

E4/4" Euro / 4.. "ollar Euro

:$G/4" $ritish Gound / 4.. "ollar 8able or terling

4"/6GD 4.. "ollar / 6apanese Den "ollar Den

4"/8H 4.. "ollar / wiss ranc "ollar wiss

4"/8%"4.. "ollar / 8anadian"ollar

"ollar 8anada

%4"/4"%ustralian "ollar / 4.."ollar

%ussie "ollar or%ussie

E4/:$G Euro / $ritish Gound Euro terlingE4/6GD Euro / 6apanese Den Euro Den

E4/8H Euro / wiss ranc Euro wiss

:$G/6GD$ritish Gound / 6apaneseDen

terling Den

**

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+he base currency

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ability. or e)ample, knowledge risk occurs when deficient knowledge is applied.

elationship risk occurs when collaboration ineffectiveness occurs. Grocesss game and is not the way most

people will achieve 0uick riches. imply because ore) trading may seem e)otic or less

familiar then traditional markets i.e. e0uities, futures, etc.&, it does not mean that the

rules of finance and simple logic are suspended. !ne cannot hope to make e)traordinary

gains without taking e)traordinary risks, and that means suffering inconsistent trading

performance that often leads to large losses. +rading currencies is not easy, and many

traders with years of e)perience still incur periodic losses. !ne must reali;e that trading

takes time to master and there are absolutely no short cuts to this process.

*3

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+he most enticing aspect of trading ore) is the high degree of leverage used. (everage

seems very attractive to those who are e)pecting to turn small amounts of money into

large amounts in a short period of time.

However, leverage is a double

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remain open until the market trades at the stop

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OBJECTIES OF RISK MANAGEMENT

#ere survivalN

Geace of mindN

(ower risk management costs and thus higher profitsN

airly stable earningsN

(ittle or no interruption of operationsN

8ontinued growthN

atisfaction of the firms sense of social responsibility desire for a good imageN

atisfaction of e)ternally imposed obligations.

STEPS IN THE RISK MANAGEMENT

PROCESS

+he core of the process is a series of five stepsJ

Establish the conte)t

Identify risks

%nalyse risks

Evaluate risks

+reat risks

In parallel with the core process, communication - consultation is re0uired to ensure

ade0uate information is provided and conclusions are disseminated. #onitoring and

review is an intrinsic part of the process re0uired to ensure that the process is e)ecuted in

a timely fashion and the identification, analysis, evaluation and treatment are kept up to

date.

1. E!'@9%! * 3/*1

*?

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Establishing the conte)t includes planning the remainder of the process and mapping out

the scope of the e)ercise, the identity and ob'ectives of stakeholders, the basis upon

which risks will be evaluated and defining a framework for the process, and agenda for

identification and analysis.

5.I2*%-%3'%/

%fter establishing the conte)t, the ne)t step in the process of managing riskis to identify

potential risks. isks are about events that, when triggered, will cause problems. Hence,

risk identification can start with the source of problems, or with the problem itself.

S/7"3* ''90!%!isk sources may be internal or e)ternal to the system that is the

target of risk management. E)amples of risk sources areJ stakeholders of a

pro'ect, employees of a company or the weather over an airport.

P"/@9*+ ''90!%!isks are related to identified threats. or e)ampleJ the threat

of losing money, the threat of abuse of privacy information or the threat of

accidents and casualties. +he threats may e)ist with various entities, most

important with shareholder, customers and legislative bodies such as the

government.

hen either source or problem is known, the events that a source may trigger or the

events that can lead to a problem can be investigated. or e)ampleJ stakeholders

withdrawing during a pro'ect may endanger funding of the pro'ectN privacy information

may be stolen by employees even within a closed networkN lightning striking a $oeing

?3? during takeoff may make all people onboard immediate casualties.

+he chosen method of identifying risks may depend on culture, industry practice and

compliance. +he identification methods are formed by templates or the development of

templates for identifying source, problem or event. 8ommon risk identification methods

areJ

*B

http://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Risk

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O@*3%>*!@'!*2 R%!& I2*%-%3'%/ !rgani;ations and pro'ect teams have

ob'ectives. %ny event that may endanger achieving an ob'ective partly or

completely is identified as risk.

!b'ectives Enterprise isk

#anagement < Integrated ramework

S3*'"%/@'!*2 R%!& I2*%-%3'%/ In scenario analysisdifferent scenarios are

created. +he scenarios may be the alternative ways to achieve an ob'ective, or an

analysis of the interaction of forces in, for e)ample, a market or battle. %ny event

that triggers an undesired scenario alternative is identified as risk.

T'1//+0@'!*2 R%!& I2*%-%3'%/ +he ta)onomy in ta)onomy

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=evertheless, risk assessment should produce such information for the management of

the organisation that the primary risks are easy to understand and that the risk

management decisions may be prioriti;ed. +hus, there have been several theories and

attempts to 0uantify risks. =umerous different risk formulae e)ist, but perhaps the most

widely accepted formula forrisk0uantification isJ

R'* /- /337""*3*multiplied by the %+8'3 /- * *>*e0uals "%!&

(ater research has shown that the financial benefits of risk management are not so much

dependent on the formulae used. +he most significant factor in risk management seems to

be that

1.& risk assessmentis performed fre0uently and

*.& it is done using as simple methods as possible.

In business it is imperative to be able to present the findings of risk assessments in

financial terms. obert 8ourtney 6r. I$#, 17?@& proposed a formulae for presenting

risks in financial terms. +he 8ourtney formulae was accepted as the official risk analysis

method for the 4 governmental agencies. +he formulae proposes calculation of %(E

%nnualised (oss E)pectancy& and compares the e)pected loss value to the security

control implementation costs cost

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Ideal use of these strategies may not be possible. ome of them may involve trade offs

that are not acceptable to the organi;ation or person making the risk management

decisions.

R%!& '>/%2'3*

Includes not performing an activity that could carry risk. %n e)ample would be not

buying a property or business in order to not take on the liability that comes with it.

%nother would be not flying in order to not take the risk that the airplanewere to be

hi'acked. %voidance may seem the answer to all risks, but avoiding risks also means

losing out on the potential gain that accepting retaining& the risk may have allowed. =ot

entering a business to avoid the risk of loss also avoids the possibility of earning the

profits.

R%!& "*273%/

Involves methods that reduce the severity of the loss. E)amples include sprinklers

designed to put out a fireto reduce the risk of loss by fire. +his method may cause a

greater loss by water damage and therefore may not be suitable. Halonfire suppression

systems may mitigate that risk, but the cost may be prohibitive as a strategy.

#odern software development methodologies reduce risk by developing and delivering

software incrementally. Early methodologies suffered from the fact that they only

delivered software in the final phase of developmentN any problems encountered in earlier

phases meant costly rework and often 'eopardi;ed the whole pro'ect. $y developing in

increments, software pro'ects can limit effort wasted to a single increment. % current

trend in software development, spearheaded by the E)treme Grogrammingcommunity, is

to reduce the si;e of increments to the smallest si;e possible, sometimes as little as one

week is allocated to an increment.

21

http://en.wikipedia.org/wiki/Propertyhttp://en.wikipedia.org/wiki/Propertyhttp://en.wikipedia.org/wiki/Liabilityhttp://en.wikipedia.org/wiki/Airplanehttp://en.wikipedia.org/wiki/Hijackhttp://en.wikipedia.org/wiki/Sprinklerhttp://en.wikipedia.org/wiki/Firehttp://en.wikipedia.org/wiki/Halonhttp://en.wikipedia.org/wiki/Strategyhttp://en.wikipedia.org/wiki/Strategyhttp://en.wikipedia.org/wiki/Extreme_Programminghttp://en.wikipedia.org/wiki/Extreme_Programminghttp://en.wikipedia.org/wiki/Propertyhttp://en.wikipedia.org/wiki/Liabilityhttp://en.wikipedia.org/wiki/Airplanehttp://en.wikipedia.org/wiki/Hijackhttp://en.wikipedia.org/wiki/Sprinklerhttp://en.wikipedia.org/wiki/Firehttp://en.wikipedia.org/wiki/Halonhttp://en.wikipedia.org/wiki/Strategyhttp://en.wikipedia.org/wiki/Extreme_Programming

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R%!& "**%/

Involves accepting the loss when it occurs. +rue self insurancefalls in this category. isk

retention is a viable strategy for small risks where the cost of insuring against the risk

would be greater over time than the total losses sustained. %ll risks that are not avoided or

transferred are retained by default. +his includes risks that are so large or catastrophic

that they either cannot be insured against or the premiums would be infeasible. aris an

e)ample since most property and risks are not insured against war, so the loss attributed

by war is retained by the insured. %lso any amounts of potential loss risk& over the

amount insured is retained risk. +his may also be acceptable if the chance of a very large

loss is small or if the cost to insure for greater coverage amounts is so great it would

hinder the goals of the organi;ation too much.

R%!& "'!-*"

#eans causing another party to accept the risk, typically by contract or by hedging.

Insuranceis one type of risk transfer that uses contracts. !ther times it may involve

contract language that transfers a risk to another party without the payment of an

insurance premium. (iability among construction or other contractors is very often

transferred this way. !n the other hand, taking offsetting positions in derivatives is

typically how firms use hedging to financially manage risk.

ome ways of managing risk fall into multiple categories. isk retention pools are

technically retaining the risk for the group, but spreading it over the whole group

involves transfer among individual members of the group. +his is different from

traditional insurance, in that no premium is e)changed between members of the group up

front, but instead losses are assessed to all members of the group.

C"*'* * 89'

"ecide on the combination of methods to be used for each risk. Each risk management

decision should be recorded and approved by the appropriate level of management. or

2*

http://en.wikipedia.org/wiki/Self_insurancehttp://en.wikipedia.org/wiki/Warhttp://en.wikipedia.org/wiki/Contracthttp://en.wikipedia.org/wiki/Hedginghttp://en.wikipedia.org/wiki/Insurancehttp://en.wikipedia.org/wiki/Insurance_premiumhttp://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Financial_risk_managementhttp://en.wikipedia.org/wiki/Self_insurancehttp://en.wikipedia.org/wiki/Warhttp://en.wikipedia.org/wiki/Contracthttp://en.wikipedia.org/wiki/Hedginghttp://en.wikipedia.org/wiki/Insurancehttp://en.wikipedia.org/wiki/Insurance_premiumhttp://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Financial_risk_management

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e)ample, a risk concerning the image of the organi;ation should have top management

decision behind it whereas I+ management would have the authority to decide on

computer virus risks.

+he risk management plan should propose applicable and effective security controls for

managing the risks. or e)ample, an observed high risk of computer viruses could be

mitigated by ac0uiring and implementing anti virus software. % good risk management

plan should contain a schedule for control implementation and responsibile persons for

those actions. +he risk management concept is old but is still not very effectively

measured

6.I+89*+*'%/

ollow all of the planned methods for mitigating the effect of the risks. Gurchase

insurance policies for the risks that have been decided to be transferred to an insurer,

avoid all risks that can be avoided without sacrificing the entity>s goals, reduce others,

and retain the rest.

;.R*>%*? '2 *>'97'%/ /- * 89'

Initial risk management plans will never be perfect. Gractice, e)perience, and actual loss

results, will necessitate changes in the plan and contribute information to allow possible

different decisions to be made in dealing with the risks being faced.

isk analysis results and management plans should be updated periodically. +here are

two primary reasons for thisJ

1. to evaluate whether the previously selected security controls are still applicable

and effective, and

*. to evaluate the possible risk level changes in the business environment. or

e)ample, information risks are a good e)ample of rapidly changing business

environment.

22

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F/"*% E13'* R%!& M''*+*

G7%2*9%*!

Dour business is open to risks from movements in competitors> prices, raw material

prices, competitors> cost of capital, foreign e)change rates and interest rates, all of which

need to be ideally& managed.

+his section addresses the task of managing e)posure to oreign E)change movements.

+hese isk #anagement :uidelines are primarily an enunciation of some good and

prudent practices in e)posure management. +hey have to be understood, and slowly

internali;ed and customi;ed so that they yield positive benefits to the company over time.

It is imperative and advisable for the %pe) #anagement to both be aware of these

practices and approve them as a policy. !nce that is done, it becomes easier for the

E)posure #anagers to get along efficiently with their task.

(=).E18/!7"* A'90!%!

%n E)posure can be defined as a 8ontracted, Gro'ected or 8ontingent 8ash low whose

magnitude is not certain at the moment. +he magnitude depends on the value of variables

such as oreign E)change rates and Interest rates.

+he company will determine and analy;e its oreign E)change e)posures.

D**"+%'%/$

+he following cash flows/ transactions will be considered for the purpose of e)posure

management.

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'"%'@9* C'! F9/?! T"'!'3%/ T08*

8ontracted oreign 8urrency 8ash lows

oreign Interest ates, whether loating or

i)ed

8ash lows from Hedge +ransactions

Gro'ected/ 8ontingent 8ash lows

$oth 8apital and evenue in

nature

%ll Interest Gayments/ eceipts

%ll !pen hedge transactions

$oth 8apital and evenue in

nature

8ash lows above C1@@,@@@/< in value will be brought to the notice of the

E)posure #anager, as soon as they are pro'ected.

It is the responsibility of the E)posure #anager to ensure that he receives the

re0uisite information on e)posures from various sections of the company in time.

A'90!%!

+hese e)posures will be analy;ed and the following aspects will be studiedJ

oreign 8urrency 8ash lows/ chedules

Kariability of 8ash flows < how certain are the amounts and/ or value datesP

Inflow

+ime #ismatches / :aps

8urrency Gortfolio #i)

loating / i)ed Interest ate ratio

(5). MARKET FORECASTS

%fter determining its E)posures, the company has to form an idea of where the market is

headed. +he company will focus on forecasts for the ne)t A months, as forecasts for

periods beyond A months can be unreliable.

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+he focus of the %pe) #anagement is to be aware of J

the "irection or the $ig +rend in rates.

the underlying assumptions behind the forecasts

the Grobability that can be assigned to the forecast coming true

the possible e)tent of the move

+he isk %ppraisal e)ercise and $enchmarking decisions will be based on such

forecasts.

().RISK APPRAISAL

+his e)ercise is aimed at determining where the company>s e)posures stand vis

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6. S0!*+! R%!&

+he risks that arise through gaps or weaknesses in the E)posure #anagement system.

or e)ampleJ

R*8/"% G'8 where there are delays/ errors in reporting e)posures to the

E)posure #anagement cellI+89*+*'%/ G'8 where there is a gap between the decision to hedge and the

implementation of such hedge decision.

(6). BENCHMARKING

+his e)ercise aims to state where the company would like its e)posures to reach.

1. +he company will set a $enchmark for its E)posure #anagement practices.*. +he $enchmarks will be set for A months periods.

2. +he $enchmark will reflect and incorporate the followingJ

i. +he !b'ective of E)posure #anagement, or in other words, Mhould E)posure

#anagement be conducted on a Grofit 8entre or 8ost 8entre basisPM

ii. +he orecasts discussed and agreed upon earlier. #athematically, the $enchmark

should be the Grobabilistic E)pectation of the rate in 0uestion.

iii. +he orecast risk, #arket and +ransaction risk, and ystems risk as determined

earlier.

iv. oom for error in keeping with the top (oss Golicy to be decided

3. +he $enchmark will be realistic and achievable.

S7*!%/!$

8ompanies whose e)posures are of long

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P"/-% C*"* under this concept, the E)posure #anager is re0uired to generate a =E+

profit on the e)posure over time. +his is an aggressive stance implying a

high degree of risk appetite on the part of %pe) #anagement. % company

with a strong position in its daily bread and butter business can afford to

take some financial risks and can opt for this concept.

+he $enchmarks under a Grofit

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re0uirement. In this regard, it will pass a $oard esolution authori;ing the use of the

followingJ

upee

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E)posure #anagement should not be undertaken without having a top

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(). REPORTING AND REIEW

+here needs to be continuous monitoring whether the E)posures are headed where they

are intended to reach. %s such, the E)posure #anagement activities need to be reported

and reviewed.

R*8/"%

+he E)posure #anager will prepare the following eports on a regular basisJ

R*8/" N'+* W' % !/?! P*"%/2%3%0

#+# eport +he #ark%*?*2

E)posure

Gerformance

E)posure =%K eport Is the $enchmark being met/

betteredPhat are the chances of the

$enchmark being violated on the

wrong sidePeasons for the $enchmark

being violated on the wrong side

#arket

ituation

eviews of market developmentsorecasts of market movements

Is the $ig +rend still in placeP !r

has it changedP

$enchmarking +he above two"oes the $enchmark need to be

changedP

Hedging #+# and E)posure =%K eports Is the strategy working wellP !r

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trategydoes it need to be fines e)periences

!perational problems to be solved

(). CONCLUSION

E)posure #anagement is an essential part of business and should be viewed with

!b'ectivity. It is neither a license to print money nor is it a cause for getting trapped in a

ear Gsychosis, and should be viewed with the same clarity of vision as, say, Groduction

or #arketing is viewed.

Having said that, it should be remembered that

%ll that has been stated above cannot start happening straightaway

Installing Hedging, eporting and eview systems that work takes time and effort

+here will be a (earning 8urve to be overcome when setting $enchmarks

+here will be initial losses, which should be viewed as what they are < initial

losses.

+here has to be a long

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foreign e)change rate risk and/or interest rate changes while, at the same time, effectively

ensuring a future financial position.

Each entity and/or individual that has e)posure to foreign e)change rate risk will have

specific foreign e)change hedging needs and this website can not possibly cover every

e)isting foreign e)change hedging situation. +herefore, we will cover the more common

reasons that a foreign e)change hedge is placed and show you how to properly hedge

foreign e)change rate risk.

F/"*% E13'* R'* R%!& E18/!7"*< oreign e)change rate risk e)posure is

common to virtually all who conduct international business and/or trading. $uying and/or

selling of goods or services denominated in foreign currencies can immediately e)pose

you to foreign e)change rate risk. If a firm price is 0uoted ahead of time for a contract

using a foreign e)change rate that is deemed appropriate at the time the 0uote is given,

the foreign e)change rate 0uote may not necessarily be appropriate at the time of the

actual agreement or performance of the contract. Glacing a foreign e)change hedge can

help to manage this foreign e)change rate risk.

I*"*! R'* R%!& E18/!7"* < Interest rate e)posure refers to the interest rate

differential between the two countries> currencies in a foreign e)change contract. +he

interest rate differential is also roughly e0ual to the McarryM cost paid to hedge a forward

or futures contract. %s a side note, arbitragers are investors that take advantage when

interest rate differentials between the foreign e)change spot rate and either the forward or

futures contract are either to high or too low. In simplest terms, an arbitrager may sell

when the carry cost he or she can collect is at a premium to the actual carry cost of the

contract sold. 8onversely, an arbitrager may buy when the carry cost he or she may pay is

less than the actual carry cost of the contract bought. Either way, the arbitrager is looking

to profit from a small price discrepancy due to interest rate differentials.

F/"*% I>*!+* S/3& E18/!7"* oreign investing is considered by many

investors as a way to either diversify an investment portfolio or seek a larger return on

investments& in an economy believed to be growing at a faster pace than investments& in

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the respective domestic economy. Investing in foreign stocks automatically e)poses the

investor to foreign e)change rate risk and speculative risk. or e)ample, an investor buys

a particular amount of foreign currency in e)change for domestic currency& in order to

purchase shares of a foreign stock. +he investor is now automatically e)posed to two

separate risks. irst, the stock price may go either up or down and the investor is e)posed

to the speculative stock price risk. econd, the investor is e)posed to foreign e)change

rate risk because the foreign e)change rate may either appreciate or depreciate from the

time the investor first purchased the foreign stock and the time the investor decides to

e)it the position and repatriates the currency e)changes the foreign currency back to

domestic currency&. +herefore, even if a speculative profit is achieved because the

foreign stock price rose, the investor could actually net lose money if devaluation of the

foreign currency occurred while the investor was holding the foreign stock and the

devaluation amount was greater than the speculative profit&. Glacing a foreign e)change

hedge can help to manage this foreign e)change rate risk.

H*2% S8*379'%>* P/!%%/! oreign currency traders utili;e foreign e)change

hedging to protect open positions against adverse moves in foreign e)change rates, and

placing a foreign e)change hedge can help to manage foreign e)change rate risk.

peculative positions can be hedged via a number of foreign e)change hedging vehicles

that can be used either alone or in combination to create entirely new foreign e)change

hedging strategies.

H/? T/ T"'2* F/"*1 S733*!!-7990$ F/"*1

T"'2% R%!& M''*+*

T"'2% * M'"&*!

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% perfect e)ample of this is the game of black'ack. +he house has a very slight edge less

than not more than *. $ut by repetitive play they consistently end up profitable. +his is

because they have a set approach, and edge, and they dont get emotional when a player

goes on a winning streak. :ood traders put themselves in the position of a casino.

+raders can make money discretionally by following support and resistance levels,

watching the volume, si;e and market action. !r, traders can create a trading system by

back

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=. I"/273%/

+he spot market accounts for nearly a third of global foreign e)change turnover. It can be

broadly divided into two tiersJ

T +he interbank market where currency is bought and sold for delivery and settlement

within two days, with the banks acting as wholesalersF or market makersF.

T +he retail market made up of private traders, who deal over the telephone or the internet

through intermediaries brokers&.

+he fore) market has no centrali;ed e)changes. %ll trades are over

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known as the big figureF while the third and fourth decimal places together measure the

pointsF or pipsF. or instance, in :$G/4" R 1.5535 the big figureF is 1.55 while the

35 i.e. the third and fourth decimal places& represents the points.

5.=. B%2 /--*" !8"*'2

%s with other financial commodities, there is a buying price offerF or askF price& and a

selling price bidF price&. +he difference is known as the bid

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Every purchase of the base currency implies a reciprocal sale of the secondary currency.

(ikewise, sale of the base currency implies the simultaneous purchase of the secondary

currency.

or e)ample, when I sell 1 :$G, I am simultaneously buying 1.5535 4". (ikewise,

when I buy 1 :$G, I am simultaneously selling 1.555@ 4".

e can e)press this e0uivalence by inverting the :$G/4" e)change rate and rotating

the bid and offer reciprocals, to derive the 4"/:$G rate i.e.

4"/:$G R 1/1.555@& bidN 1/1.5535& offer R @.A321/22

+his means that the bid price of one 4" is @.A321 :$G or A3.21p& and the offer price

of one 4" is @.A322 :$G or A3.22p&. =ote that 4" has now become the base

currency and that the spread is * points.

6. P"'3%3'9 !8/ "'2%

6.= U%! /- "'2% 9/!

%s we have already seen, every fore) transaction is an e)change of one currency for

another. +he basic unit of trading for private investors is known as a lotF which consists

of 1@@,@@@ units of the base currency although some brokers may arrange trading in

mini

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ince the sale of one currency involves the simultaneous purchase of another, the seller of

a :$G/4" lot will have bought a volume of 4", and will also have to put down

margin for the value of the deal 15B,3?@ 4"&.

+he normal margin re0uirement is between 1 and 5 of the underlying value of the

trade.

+he currency denomination depends on the brokerage through which you e)ecute your

trade. If you are dealing through an %merican broker say online&, then it is likely that

you will have to deposit margin in 4" even if you are resident in the 49.

ith 5,@@@ 4" in your margin account and with margin re0uirement of *.5, you can

open positions worth *@@,@@@ 4". Dour positions will be valued continuously. If the

funds in your margin account drop below the minimum re0uired to support your open

positions, then you may be asked to provide additional funds. +his is known as a margin

callF.

If your trade is denominated in a currency other than that accepted by the

broker, you will have to convert your gains and losses back into an acceptable currency.

or e)ample, if you trade a 4"/6GD pair, then your gains and losses will be

denominated in 6GD. If your brokers home currency is 4", then your profits and losses

will be converted back to 4" at the relevant 4"/6GD offer rate.

6. C9/!% /7

%n open position is one that is live and ongoing. %s long as the position is open, its value

will fluctuate in accordance with the e)change rate in the market. %ny profits and losses

will e)ist on paper only and will be reflected in your margin account.

+o close out your position, you conduct an e0ual and opposite trade in the same currencypair. or e)ample, if you have gone long in one lot of :$G/4" at the prevailing offer

price& you can close out that position by subse0uently going short in one :$G/4" lot

at the prevailing bid price&.

Dour opening and closing trades must the conducted through the same intermediary. Dou

cannot open a :$G/4" position with $roker % and close it out through $roker $.

5@

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;. W/"&*2 *1'+89*

;.= B*% / ' "%!*

%ssume that you start with a clean slate and that the current :G$/4" rate is 1.5B3?/5*.

T Dou e)pect the pound to appreciate against the 4 dollar, so you buy a single lot of

1@@,@@@ :$G at the offer price of 1.5B5* 4".

T +he value of the contract is 1@@,@@@ L C1.5B5* R C15B, 5*@.

+he broker wants margin of *.5 in 4", so you must ensure that you deposit at least

*.5 of 15B,5*@ 4" R 2,7A2 4" in your margin account

T :$G/4" duly appreciates to 1.A@@@/@5 and you decide to close out your position by

selling your sterling for 4 dollars at the bid rate. Dour gain isJ

1@@,@@@ L 1.A@@@ 1.5B5*& 4" R 1,3B@ 4", the e0uivalent of 1@ 4" per point

T Dour rate of return is 1,3B@/2,7A2 R 2?.25, on an e)change rate movement of less than

1. +his illustrates the positive effect of buying on margin.

T Had :$G/4" fallen to 1.5?@@/?5, your loss would have beenJ

1@@,@@@ L 1.5B5* 1.5?@@& 4" R 1,5*@ 4", a return of 2B.25

+he lesson is that margin trading magnifies your rate of profit or loss.

. S3"**@'!*2 !8/ "'2%

+he technology for trading fore) has evolved from the telephone and tele) not forgetting

voice dealing& through to the modern Electronic $roking ystem E$& that enables

straight through processingF +G& with integrated 0uotation, transactional and

administrative functionality.

E$

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T % margin account broker with internet access and a fast connection

T % computer terminal capable of running several programmes simultaneously

T Groprietary software to open and manage positions and to display technical analysis

tools.

T ufficient monitors to handle market data, submit dealing instructions, display technical

analysisN and for keeping tabs on open positions, managing orders e.g. stop loss, +G!,

limit etc.& and viewing the state of the margin account. or demonstrations of the kind of

proprietary software available, visit Gronet %nalytics www.pronetanalytics.com& and

=ostradamus www.nostradamus.co.uk&

Gronet %nalytics provides the only chart

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('). T* @'9'3* /- "'2*$8urrencies that are associated with long term trade

surpluses will tend to strengthen against those associated with persistent deficits < simply

because there is net buying of surplus currencies corresponding to the e)cess of e)ports

over imports.

+rends are important too. %n improving balance of trade should cause the relevant

currency to appreciate relative to those associated with a deteriorating or stable balance

of trade.

b&. R*9'%>* %-9'%/ "'*!$If country % is suffering a higher rate of price inflation

than country $, then %s currency ought to weaken relative to $s in order to restore

purchasing power parityF.

c&. I*"*! "'*!$ International capital flows seek the highest inflation

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identify trends and recurring patterns in a volatile marketplace. %spiring fore) dealers are

advised to undergo proper training in technical analysis, although true proficiency comes

with practice, endurance and e)perience.

TREND CLASSIFICATIONS

DRAWING TRENDLINES+he basic trendline is one of the simplest technical tools employed by the trader, and is

also one of the most valuable in any type of technical trading.

or an up trendline to be drawn, there must be at least two low points in the graph where

the *nd low point is higher than the first.

% price low is the lowest price reached during a counter trend move.

BULLISH TREND LINES

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TREND, ANALYSIS AND TIMING

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#arkets don>t move straight up and down. +he direction of any market at any time is

either $ullish 4p&, $earish "own&, or =eutral ideways&. ithin those trends, markets

have countertrend backing - filling& movements. In a general sense M#arkets move in

wavesM, and in order to make money a trader must catch the wave at the right time.

DRAWING ARIOUS TRENDLINES

DRAWING TRENDLINES

5A

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TRENDLINES

"rawing +rendlines will help to determine when a trend is changing.

TREND

+he direction of trend is absolutely essential to trading and analy;ing the market .

5?

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In the oreign E)change L& #arket it is possible to profit from 4G and "own

movements, because of the buying of one currency and selling against the other currency

e.g. $uy 4 "ollar ell :erman #ark. e). 4p +rend chart.

. T%8! -/" '!8%"% !8/ "'2*"!

%ndy hearman, a director of fore) day

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1& "ont be under

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% forward contract that locks

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4"/E4. +he change in price is@.@@?1 4"/E4. %s eachcontract is over E4 1*5,@@@, andhe has 1@ contracts, his profit is4" B,B?5. %s with any future,

this is paid to him immediately.#ore generally, each change of@.@@@1 4"/E4 the minimumtick si;e&, is a profit or loss of4" 1*.5 per contract.

Investors use these futures contracts to hedgeagainst foreign e)change risk. +hey can

also be used to speculate and, by incurring a risk, attempt to profit from rising or falling

e)change rates. Investors can close out the contract at any time prior to the contract>s

delivery date.

8urrency futures were first created at the 8hicago #ercantile E)change8#E& in 17?*,

less than one year after the system of fi)ed e)change rateswas abandoned along with the

gold standard.ome commodity traders at the 8#E did not have access to the inter

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trading environment through which customers collectively place trades worth up

to C2*.1 billion 8#E single

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futures contracts were introduced at the 8$!+ in !ctober 17B* when the e)change began

trading !ptions on 4.. +reasury $ond futures.

W' A"* O8%/!

+here are two basic types of options on futures contractsJ McallsM and Mputs.M % 3'99

/8%/on futures contracts conveys the right but not the obligation& to the buyer to

purchase a specific futures contract for e)ample, a corn contract for a "ecember 177?

delivery month& at a particular price during a specified period of time. % 87 /8%/

conveys the right but not the obligation& to the buyer to sell a specific futures contract at

a given price during a specified period of time. +he price for which the futures contract

can be brought in the case of a call option& or sold in the case of a put option& under theterms of the option contract is referred to as the option>s !"%&* 8"%3*or *1*"3%!* 8"%3*.

+he date on which an option e)pires

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a put option. +rading a put does not involve a call option. 8alls and puts are separate

contracts, not opposite sides of the same transaction.

%t any given time, there is simultaneous trading in a number of different call and put

options

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he or she can gain, since the option seller faces the possibility of the option being

e)ercised against him or her. hen an option is e)ercised, the futures position assigned to

an option seller will almost always be a losing one, since only an in

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+here are several important terms the would

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call option strike price is ?B, the call is in

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instances, margin would be re0uired because the seller would be obligated to fulfill terms

of the option contract in the event the contract is e)ercised by the buyer. It is imperative,

therefore, that the seller demonstrate the ability to meet any potential contractual

obligations beforehand. In addition, the seller of uncovered options on interest rate

futures assumes the potential for significant losses.

M/%>*! -/" B70% '2 S*99% O8%/!

!ne may be a buyer or seller of call or put options for a variety of reasons.

% call option b*yer, for e)ample, is bullish. +hat is, he or she believes the price of the

underlying futures contract will rise. If prices do rise, the call option buyer has three

courses of action available.+he first is to e)ercise the option and ac0uire the underlying futures contract at the strike

price. +he second is to offset the long call position with a sale and reali;e a profit. +he

third, and least acceptable, is to let the option e)pire worthless and forfeit the unreali;ed

profit.

+hesellerof the call option e)pects futures prices to remain relatively stable or to decline

modestly. If prices remain stable, the receipt of the option premium enhances the rate of

return on a covered position.

If prices decline, selling the call against a long futures position enables the writer to use

the premium as a cushion to provide downside protection to the e)tent of the premium

received.

or instance, if +

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+he perspectives of the put buyer and put seller are completely different. +he buyer of the

put option believes prices for the underlying futures contract will decline. or e)ample, if

a +

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O8%/ P"*+%7+ '97'%/

+he price value& of an option premium is determined competitively by open outcry

auction on the trading floor of the 8$!+. +he premium is affected by the influ) of buy

and sell orders reaching the e)change floor. %n option buyer pays the premium in cash to

the option seller. +his cash payment is credited to the seller>s account.

Grices for +

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R 2 1@/A3 < *

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8urrency riskJ If the rupee depreciates against 4", it will be more e)pensive for

the corporate to service its loan

Interest rate riskJ %n upward movement in (I$! would increase the cost of

servicing the loan

In order to hedge its risks the corporate can enter into a currency swap where it moves

from 4" floating rate loan to a I= fi)ed rate loan. +he currency swap could be

represented as followsJ

8urrency waps therefore enable a swap into both, a different currency and a different

interest rate basis. ome of the advantages of currency swaps areJ

Enables moving a liability from one currency into another

8an be customi;ed

8an be reversed at any time at a cost or benefit&

!ff $alance heet, and does not change the terms of the e)isting liability.

8urrency swaps can be structured to synthetically move liabilities in one currency to

another depending on which risks and what costs are acceptable. +he interest rates on

either of the legs can be floating or fi)ed.

It is also possible to move rupee liabilities into foreign currencies through currency

swaps. 8orporates wishing to match currency of loan repayments with currency of

receivables for e)ample, e)porters having a long tenor upee liabilities& could enter into

such swaps. 8orporates could also undertake such swaps if they wish to take advantage

of lower interest rates in return for e)change rate risk.

8onsider a corporate that has an I= *5 8rores loan at 7 fi)ed rate, repayable bullet at

the end of two years. If this corporate wishes to swap its liability into a 4" loan, the

structure of the loan would be as followsJ

+he cash flows in this swap would be as followsJ

?*

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.A %3*8%/

=one. +he loan is notionally converted from I= into 4" at current 4"I= spot rate.

+hese will then be the principal amounts on which the interest will be computed.

.E>*"0 +/!

8ompany pays to the bank A month 4" (I$! plus a spread on the notional 4"

principal

8ompany receives from the bank upee interest Z 7 on the notional I= principal

.A +'7"%0

8ompany receives I= principal from I"$I $ank.

Gays 4" principal to the I"$I $ank.

+he company therefore gains from a lower interest rate loan, for which it bears the cost of

I= depreciation against 4" during the tenor of the swap.

8urrency swaps can be used to move from any currency to any other desired currency

and interest rate.

or e)ample, a corporate could swap its I= liability into 6GD to benefit from the low

6GD interest rates. +he risk of adverse 6GD/4" e)change rate movement can be limited

to desired levels at a price. uch products can be customi;ed to suit specific corporate

interest.

It is also possible to structure swaps to hedge specific risks. or e)ample, there could be

swap such that only the principal amount of a foreign currency loan is protected at

current e)change rates Grincipal !nly wap&. 8oupon swaps swaps involving only

interest payments and no principal amounts is another such variant.

?2

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THE EXCHANGE OF PRINCIPAL AT INCEPTION AND AT

MATURITY

In an interest rate swap, we were concerned e)clusively with the e)change of cash flowsrelating to the interest payments on the designated notional amount. However, there was

no e)change of notional at the inception of the contract. +he notional amount was the

same for both sides of the currency and it was delineated in the same currency. Grincipal

e)change is redundant.

However, in the case of a currency swap, principal e)change is not redundant. +he

e)change of principal on the notional amounts is done at market rates, often using the

same rate for the transfer at inception as is employed at maturity.

or e)ample, consider the 4

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Interest rate swaps allow companies to focus on their comparative advantage in

borrowing in a single currency in the short end of the maturity spectrum vs. the longs notional at a fi)ed rate. +he more actual market rates have deviated from this

contracted rate, the greater the potential loss or gain.

+his potential e)posure is magnified with time. Kolatility increases with time.

+he longer the contract, the more room for the currency to move to one side

or other of the agreed upon contracted rate of principal e)change.

+his e)plains why currency swaps tie up greater credit lines than regular interest rate

swaps.

PRICING

e price or value currency swaps in the same way that we learned how to price interest

rate swaps, using a discounted cash flow analysis having obtained the ;ero coupon

version of the swap curves.

?5

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:enerally, currency swaps transact at inception with a net present value of ;ero. !ver the

life of the instrument, the currency swap can go in

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else are known as "erivativesF.

In more simpler form, derivatives are financial security such as an option or future whose

value is derived in part from the value and characteristics of another security, the

underlying asset.

It is a generic term for a variety of financial instruments. Essentially, this means you buy

a promise to convey ownership of the asset, rather than the asset itself. +he legal terms of

a contract are much more varied and fle)ible than the terms of property ownership. In

fact, its this fle)ibility that appeals to investors.

hen a person invests in derivative, the underlying asset is usually a commodity, bond,

stock, or currency. He bet that the value derived from the underlying asset will increase

or decrease by a certain amount within a certain fi)ed period of time.

[utures and [options are two commodity traded types of derivatives. %n [options

contract gives the owner the right to buy or sell an asset at a set price on or before a given

date. !n the other hand, the owner of a [futures contract is obligated to buy or sell the

asset.

+he other e)amples of derivatives are warrants and convertible bonds similar to shares

in that they are assets&. $ut derivatives are usually contracts. $eyond this, the derivatives

range is only limited by the imagination of investment banks. It is likely that any person

who has funds invested, an insurance policy or a pension fund, that they are investing in,

and e)posed to, derivatives wittingly or unwittingly.

hares or bonds are financial assets where one can claim on another person or

corporationN they will be usually be fairly standardi;ed and governed by the property of

securities laws in an appropriate country.

??

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!n the other hand, a contract is merely an agreement between two parties, where the

contract details may not be standardised.

"erivatives securities or derivatives products are in real terms contracts rather than solid

as it fairly sounds.

SIGNIFICANCE OF THE STUDY

ore) market is changing day by day showing a wide growth in the economy.

ore) market is more volatile in nature.

?B

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+here are different factors like speculation, hedging which force different people to

enter in different markets.

+here is risk in oreign market and various isk management strategies are there to

manage it.

isk management is done in order to minimi;e the adverse effects of potential losses

at the least possible cost.

How a person manages risk in foreign market, it depends upon his needs and

perception.

How a person trades in foreign market.

"ue to all these factors, one can interpret that foreign market plays a significant role in

economy of any country and risk is managed by different strategies in foreign market to

ma)imi;e profit in the long run and that give a boost to the economy.

ANALYSIS AND INTERPRETATIONSU2*"!'2% S"'*0 '2 A'90!%!

?7

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All successful traders have a carefully thought out system that they follow to make

profitable trades. +his system is generally based on a strategy that allows them to find

good trades. %nd the strategy is based on some form of market analysis. uccessful

traders need some way to interpret and even predict some of the movements of the

market.

+here are two basic approaches to analysing market movements, in both e0uity markets

and the !EL market. +hese are technical analysis and fundamental analysis. However,

technical analysis is much more likely to be used by traders. till, its good to have an

understanding of both types of analysis, so that you can decide which type would work

best for your system.

F72'+*'9 A'90!%!

In fundamental analysis, you are basically valuing either a business, for e0uity markets,

or a country, for !EL. If you think it>s hard enough to value one company, you should

try valuing a whole country. It can be 0uite difficult to do, but there are indicators that can

be studied to give insight into how the country works. % few indicators you might want to

study areJ =on

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the market. +wo important meetings that you should watch for are the ederal !pen

#arket 8ommittee and the Humphrey Hawkins Hearings.

6ust by reading the reports and e)amining the commentary, a !EL fundamental

analyst can get a better understanding of most long

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You can never have too many tips or tricks up your sleeve when you are trading. #ost of

the tips Im including here are received wisdom, trading truisms that you should

remember. +hey apply to all markets, but are particularly useful in a volatile and

technical market like the !EL

1. Gay attention to the market. E)it and enter trades based on market information.

"ont wait for a price you think the currency should hit when the market has

changed direction on you.

*. +here are times when, due to a lack of li0uidity or e)cessive volatility, you should

not trade at all. !n a similar note, never trade when you are sick. Dou cant count

on yourself to be alert to the shifts of the markets, and make good decisions.

2. +rading systems that work in an up market may not work in a down market, and a

system that works for trending markets, or for range bound markets may not work

in other markets. Have a system for each type of market.

3. 4p market and down market patterns are %(%D there, but you have to look for

the dominant trends. %lways select trades that move with the trends

5. "uring the blowout stage of the market, either up or down, the risk managers are

usually issuing margin call position li0uidation orders. +hey don>t generally check

the screen to see whats overbought or oversoldN they 'ust keep issuing li0uidation

orders. #ake sure you stay out of their way.

A. +rust your instincts. If something feels wrong about a trade, dont make it. Its

better to be superstitious than to loose money.

?. umour is king. $uy when you hear the rumour, sell when you hear the news.

B. +he first and last ticks are always the most e)pensive. :et in the market late, and

out early. %nd never trade in the direction of a gap, either opening or closing.

7. hen everyone else is in, it>s time for you to get out. If a stock or currency is

overbought, its time to e)it your position.

1@. "ont worry about missing out on an opportunity to trade. +here will always be

another good one 'ust around the corner. If the trade you are considering doesnt

meet all your entry signals but it seems to good to pass up, remember, youre

never going to run out of trades you can make.

B*

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11. "ont get too confident. =o one can predict the market with 1@@ accuracy. Dou

need to always e)pect the une)pected. If you become uneasy, or the market

becomes choppy, e)it your trades.

1*. "on>t turn three losing trades in a row into si). hen youre off, turn off the

screen, do something else. !ften the best way to break a streak of consecutive

loses is to not trade for a day.

12. $ut, don>t stop trading when youre on a winning streak.

13. #easure your success by the profit made in a day, not on a trade. Its even better

to measure it over two or three days. % successful traders goal is to make money,

not to win on every trade.

15. calpers reduce the number of variables affecting market risk by being in a

position only for a few seconds. "ay traders reduce market risk by being in trades

for minutes. If you convert a scalp or day trade into a position trade, you

probably didnt analy;e the risks of the trade properly.

1A. +here is no secret to understanding the market. Dou can spend much of your

valuable time and money looking for these kinds of secrets. Its better to take the

time to create a solid trading system, and reali;e that the secret to success is hard

work.

1?. =ever ask for someone else>s opinion, they probably didnt do as much homework

as you did anyways.

1B. hen the market is going up, say it out loud. hen the market is going down, say

that out loud too. Doull be ama;ed at how hard it is to say what is going on right

in front of you when you want it the market to be doing something else.

HOW TO AOID TYPICAL PITFALLS AND STARTMAKING MORE MONEY IN YOUR FOREX TRADING

B2

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=. T"'2* 8'%"!, / 37""*3%*! (ike any relationship, you have to know both

sides. uccess or failure in fore) trading depends upon being right about both

currencies and how they impact one another, not 'ust one.

5. K/?9*2* %! P/?*" hen starting out trading fore) online, it is essential that

you understand the basics of this market if you want to make the most of your

investments.

. U'+@%%/7! "'2% #any new traders will place very tight orders in order to

take very small profits. +his is not a sustainable approach because although you

may be profitable in the short run if you are lucky&, you risk losing in the longer

term as you have to recover the difference between the bid and the ask price

before you can make any profit and this is much more difficult when you make

small trades than when you make larger ones.

6. O>*"3'7%/7! "'2% (ike the trader who tries to take small incremental

profits all the time, the trader who places tight stop losses with a retail fore)

broker is doomed. %s we stated above, you have to give your position a fair

chance to demonstrate its ability to produce. If you don>t place reasonable stop

losses that allow your trade to do so, you will always end up undercutting yourself

and losing a small piece of your deposit with every trade.

;. I2*8*2*3* If you are new to fore), you will either decide to trade your own

money or to have a broker trade it for you. o far, so good. $ut your risk of losing

increases e)ponentially if you either of these two thingsJ

Interfere with what your broker is doing on your behalf as his strategy might

re0uire a long gestation period&N

eek advice from too many sources < multiple input will only result in multiple

losses. +ake a position, ride with it and then analyse the outcome < by yourself, for

yourself.

. T%0 +'"%! #argin trading is one of the biggest advantages in trading fore)

as it allows you to trade amounts far larger than the total of your deposits.

However, it can also be dangerous to novice traders as it can appeal to the greed

B3

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factor that destroys many fore) traders. +he best guideline is to increase your

leverage in line with your e)perience and success.

. N/ !"'*0 +he aim of making money is not a trading strategy. % strategy is

your map for how you plan to make money. Dour strategy details the approach

you are going to take, which currencies you are going to trade and how you will

manage your risk. ithout a strategy, you may become one of the 7@ of new

traders that lose their money.

. T"'2% O--P*'& H/7"! Grofessional L traders, option traders, and hedge

funds posses a huge advantage over small retail traders during offt.

. T* /90 ?'0 %! 782/? hen the market is on its way up, the market is on its

way up. hen the market is going down, the market is going down. +hat>s it.

+here are many systems which analyse past trends, but none that can accurately

predict the future. $ut if you acknowledge to yourself that all that is happening at

any time is that the market is simply moving, you>ll be ama;ed at how hard it is to

blame anyone else.

=t undertake the trade. +he spread you are trading on will make the odds

against you far too high.

B5

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=. D/ @* !+'" +he most successful traders I know keep their trading simple.

+hey don>t analyse all day or research historical trends and track web logs and

their results are e)cellent.

=6. T/8! '2 B//+! +here are no real MbargainsM in trading foreign e)change.

+rade in the direction the price is going in and you>re results will be almost

guaranteed to improve.

=;. I/"% * *3%3'9! 4nderstanding whether the market is overt tend to make the

wisest decisions. "on>t let your emotions sway you.

=. C/-%2*3* 8onfidence comes from successful trading. If you lose money early

in your trading career it>s very difficult to regain itN the trick is not to go off halfs

ongoing regular performance over months and years that makes a good trader.

5. F/37! antasi;ing about possible profits and then MspendingM them before you

have reali;ed them is no good. ocus on your current positions& and place

BA

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reasonable stop losses at the time you do the trade. +hen sit back and en'oy the

ride < you have no real control from now on, the market will do what it wants to

do.

. D/ "7! 2*+/! "emo trading often causes new traders to learn bad habits.

+hese bad habits, which can be very dangerous in the long run, come about

because you are playing with virtual money. !nce you know how your broker>s

system works, start trading small amounts and only take the risk you can afford to

win or lose.

6. S%3& / * !"'*0 hen you make money on a well thoughtt go and lose half of it ne)t time on a fancyN stick to your strategy and

invest profits on the ne)t trade that matches your long

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and down are individual to each cross, so study them and learn from your

e)perience and apply your learning to one cross at a time.

=t taken one. +his level of detachment is

essential if you want to retain your clarity of mind and avoid succumbing to

emotional impulses and therefore increasing the likelihood of incurring losses. +o

achieve this, you need to cultivate a calm and rela)ed outlook. +rade in brief

periods of no more than a few hours at a time and accept that once the trade has

been made, it>s out of your hands.

=. D**"+%'%/ !nce you have decided to place a trade, stick to it and let it run

its course. +his means that if your stop loss is close to being triggered, let it

trigger. If you move your stop midway through a trade>s life, you are more than

likely to suffer worse moves against you. Dour determination must be show itself

when you acknowledge that you got it wrong, so get out.

=6. S/"*"+ M/>% A>*"'* C"/!!/>*"! < +his is one of the most dangerous

trade scenarios for non professional traders. hen the short

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